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Carve out benefits from special needs trust

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A family with a disabled child may choose to use one of the new ABLE (Achieving a Better Life Experience Act) accounts for the child. But ABLE accounts are restricted to individuals who experienced the onset of a significant disability before age 26, among other requirements.

Strategy: Set up a special needs trust, when warranted. This tried-and-true type of trust can be used instead of an ABLE account or as a supplement to an ABLE account.

Not only can such a trust meet a disabled child’s needs throughout his or her lifetime, it can help preserve assets for other children in the family.

Here’s the whole story: A special needs trust (sometimes called a “supplemental trust”) is an irrevocable trust designed to supplement public assistance benefits for a disabled child. The trust assets and income can be used to pay for items such as travel, education, recreation, rehabilitation and medical expenses that are not covered by public assistance.

The trust must direct the trustee to use the assets only to supplement benefits available to the disabled child. Conversely, if the trust funds are used as a primary means of support, the disabled individual may be ineligible for public assistance, including Medicaid.

For example, the trust should not use language directing the trustee to use trust funds for support, maintenance, welfare and education of the disabled child. If trust funds can be used for basic support items, the funds may be considered assets that are available to the disabled child in determining eligibility for benefits.

Also, some states have enacted legislation that excludes assets in a special needs trust when determining eligibility for benefits. In certain states, assets remaining in the trust when the disabled child dies must be used to pay back benefits that were provided during the child’s life. Nevertheless, the trust assets will be available to meet the child’s special needs while he or she is alive.

Funds placed in a special needs trust don’t qualify for the annual gift tax exclusion ($14,000 per recipient in 2016). Due to the restrictions on the use of the trust funds, the tax law considers this type of trust to be a gift of a future interest, which isn’t eligible for the annual exclusion. To shelter the trust contributions from gift tax, you must use part of the unified estate and gift tax exemption available.

Tip: The exemption for 2016 is $5.45 million (up from $5.43 million in 2015), giving most families plenty of leeway.

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